Merchant Company Found Themselves in Need of Cash

question 4

Essay

Merchant Company found themselves in need of cash. In an effort to shore up their financial situation they sold land to Natalie Company for $3.5 million and immediately leased it back.
1) The land was recorded on Merchant's book at $1.5 million
2) The term of the noncancelable lease is 20 years.
3) The lease agreement requires equal rental payments of $439,518 at the end of each year.
4) The incremental borrowing rate of Merchant's is 12% but the annual rental rate of 11% was set by Natalie, and Merchant is aware of the rate.
5) Merchant pays all executory costs which amount to $11,500 per year which includes taxes and insurance.
6) There are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor, and the collectibility is reasonably assured.
7) The land's fair value is $3.5 million.
8) Natalie provided Merchant with the option to purchase the land at the end of the 20 years for $1,000.
Required:
1) Prepare the seller-lessee journal entries for Merchant, for the 2014 sale and leaseback agreement. (Ignore the bargain purchase option because it is immaterial)
2) Prepare any journal entry that Merchant should make related to the gain at the end of 2014.

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Definitions:

Vicious Circle

A complex chain of events that reinforce themselves through a feedback loop, leading to a detrimental situation.

Poverty

A state or condition in which individuals or communities lack the financial resources and essentials for a minimum standard of living.

Capital-Using Technologies

Innovations that increase the efficiency of capital usage, often leading to higher productivity but possibly requiring more initial investment.

Capital-Saving Technologies

Innovations that allow for the same level of production using fewer inputs of capital, usually leading to cost savings and increased efficiency.